Treatment of Business Profits under the Canada-US Tax Treaty

In this article we will briefly examine the treatment of the business profits of a resident of a contracting State under the Canada-US Income Tax Convention, and the important definition of a “permanent establishment” for purposes of determining the potential taxability of income of such profits.

This article is intended to provide informative material for US taxpayers involved with US-Canada cross-border businesses, and is not intended to constitute tax or legal advice. Please contact the experienced international tax law firm of Sherayzen Law Office, Ltd. for issues involving the Canada-US Tax Treaty.

Business Profits under the Canada-US  Tax Treaty

Under the US-Canada Tax Treaty, the business profits of a resident of a Contracting State, “[S]hall be taxable only in that State unless the resident carries on business in the other Contracting State through a permanent establishment situated therein.” (See the definition of “permanent establishment” in next section). Hence, if the resident of a Contracting State carries on, or has carried on, such business, then the business profits of the resident may be taxed in the other State but only to the extent attributable to the permanent establishment.

In determining the business profits of a permanent establishment, certain deductions incurred for the purposes of the permanent establishment, such as executive and general administrative expenses (whether in the State in which the permanent establishment is situated, or elsewhere) may be allowed. However, under the Canada-US Tax Treaty, a Contracting State is not required to allow the deduction of an expenditure which is not generally deductible under the taxation laws of such State.

Additionally, the Canada-US Tax Treaty states that “no business profits shall be attributed to a permanent establishment of a resident of a Contracting State by reason of the use thereof for either the mere purchase of goods or merchandise or the mere provision of executive, managerial or administrative facilities or services for such resident.”

Definition of Permanent Establishment under the Canada-US Tax Treaty

Article V of the Canada-US Tax Treaty provided the original definition of the term “permanent establishment”. As stated in the Canada-US Tax Treaty, the term is defined to mean “[a] fixed place of business through which the business of a resident of a Contracting State is wholly or partly carried on.” Under the Canada-US Tax Treaty, permanent establishment includes: (a) a place of management; (b) a branch; (c) an office; (d) a factory; (e) a workshop; and (f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources. Furthermore, a building site or construction or installation project constitutes a permanent establishment provided that it lasts more than 12 months. In addition, “A person acting in a Contracting State on behalf of a resident of the other Contracting State other than an agent of an independent status to whom paragraph 7 applies shall be deemed to be a permanent establishment in the first-mentioned State if such person has, and habitually exercises in that State, an authority to conclude contracts in the name of the resident.” (Please see Article V of the Canada-US Tax Treaty for more specific examples of a “permanent establishment”).

The Fifth Protocol (the “Protocol”) to the Canada-US Tax Treaty, signed in September of 2007 and entered into force on December 15, 2008, further modified the definition of permanent establishment. Under the Protocol (Article 3, Paragraph 2), an “enterprise of a Contracting State” that provides services in the other Contracting State may be deemed to have a permanent establishment if it meets at least one of the following conditions:

“(a) Those services are performed in that other State by an individual who is present in that other State for a period or periods aggregating 183 days or more in any twelve-month period, and, during that period or periods, more than 50 percent of the gross active business revenues of the enterprise consists of income derived from the services performed in that other State by that individual; or (b) The services are provided in that other State for an aggregate of 183 days or more in any twelve-month period with respect to the same or connected project for customers who are either residents of that other State or who maintain a permanent establishment in that other State and the services are provided in respect of that permanent establishment.”

Further, the diplomatic notes of Annex B to the Protocol added that, “[t]he principles of the OECD Transfer Pricing Guidelines shall apply for purposes of determining the profits attributable to a permanent establishment”.

Elimination of Article XIV of the Canada-US Tax Treaty

The Protocal had further important impact with respect to services defined as “Independent Personal Services” – Article 9 of the Protocol eliminated Article XIV of the Canada-US Tax Treaty (“Independent Personal Services”). Under previous Article XIV a resident of a Contracting State performing independent personal services in the other Contracting State could be taxed if such “individual has or had a fixed base regularly available to him in that other State but only to the extent that the income is attributable to the fixed base.” The business profits rules explained above and the various definitions of permanent establishment now determine the taxability of such cases.

Contact Sherayzen Law Office for legal help with respect to Canada-US Tax Treaty

Treaty interpretation, international tax resolution and international tax planning may involve very complex issues, and it is advisable to seek the assistance of an international tax attorney in this area. This is why it is advised that you contact Sherayzen Law Office to secure professional legal help involving issues related to Canada-US Tax Treaty.

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Swiss Bank Letters Cause Legal Complications for U.S. Taxpayers

The Swiss Bank letters continue to pour into the mailboxes of U.S. taxpayers with bank and financial accounts in Switzerland as the April 30th deadline approaches for many Swiss banks that participate in the ongoing U.S. Department of Justice (“DOJ”) The Program for Non-Prosecution Agreements or Non-Target Letters for Swiss Banks (the “Program”). In an earlier article, I already discussed what the Swiss Bank letters contain, and the importance of the need for the comprehensive analysis of the offshore voluntary disclosure options. In this article, I would like to concentrate on another aspect of Swiss Bank letters – the top three legal complications that these Swiss Bank letters cause to U.S. taxpayers.

1. Swiss Bank Letters Provide Notice of Non-Compliance with the FBAR and Other International Tax Compliance Requirements

The first problem with the Swiss Bank Letters is that they provide the notice of non-compliance with the FBAR and other important international tax requirements (depending on the Bank, it can include such Forms as 5471, 8865, 926, 3520 and so on). The issue here is not so much that the Banks are making their U.S. taxpayers aware of the U.S. tax reporting requirements, but the context in which this is done.

If the Swiss Bank letters were to arrive upon the opening of a Swiss bank account or, at least, prior to the Program, it would be a huge benefit to the unsuspecting U.S. taxpayers. However, this is not the case. Rather, the notice of these requirements is given after a potentially substantial period of non-compliance with these requirements.

Moreover, the Swiss Bank letters provide a notice of non-compliance in the context of forced disclosure under the terms of the Program. Such notice has a potential to taint disclosures outside of the OVDP with the same air of the taxpayer being “forced” to disclose as opposed to doing it voluntarily (at the very least, the argument that the taxpayer is doing this disclosure without any pressure from the IRS definitely loses credibility).

Finally, the Swiss Bank letters provide a Notice of non-compliance with requirements, without even attempting to educate their audience about these requirements or suggesting to contact an international tax attorney to see if these taxpayers are really in violation of these requirements. For example, how would a taxpayer know whether Form 3520 requirement actually applies to him?

2. Swiss Bank Letters Start the Clock for Disclosure Under Extreme Time Pressure

The second problem with Swiss Bank letters is that they start the clock for the taxpayer to be able to disclosure his accounts voluntarily under an enormous time pressure. A lot of the banks that send these Swiss Bank letters will disclose by April 30, 2014. This means that the taxpayers who receive the Notice today have less than two months to disclose their accounts voluntarily before they run an enormous risk of prior disclosure of their accounts by Swiss banks to the IRS (with the effect on potentially preventing these taxpayers from entering into the OVDP). Even the taxpayers who received notices at the end of last year and January of this year are not much better off.

This is a very big problem, because time pressure may not allow the taxpayers to choose the right type of voluntary disclosure. Moreover, even if they wanted to do one type of disclosure rather than another, their options may be limited due to insufficient time to implement the strategies necessary to make their preferred choice of the voluntary disclosure successful.

3. Swiss Bank Letters May Mislead U.S. Taxpayers in Believing that OVDP is the Only Option

Swiss Bank letters uniformly advise their clients to enter into the OVDP without ever mentioning any alternatives. It is as if the assumption of willful failure to file FBARs is already written into the Swiss Bank letters. Theoretically, one could even argue that, by advising taxpayers to enter the OVDP instead of consulting an international tax attorney about their options, some of the Swiss Bank letters over-step their boundaries and enter the world of giving legal advice without a license.

At the practical level, the problem is even more profound. The Swiss Bank letters have the potential to mislead U.S. taxpayers with undisclosed accounts into believing that OVDP is the only option available to them and they have to take this option because their bank will soon disclose their accounts to the IRS. While, undoubtedly, OVDP may be the best option in many cases, this may not be true in other cases. The problem is that, the way Swiss Bank letters are drafted, the U.S. taxpayers may never be even given the choice.

Contact Sherayzen Law Office for Help If You Received Swiss Bank Letters

Sherayzen Law Office is here to help you with the voluntary disclosure of your Swiss bank and financial accounts. Owner Eugene Sherayzen is an international tax attorney and expert in this field who can analyze the facts of your case and explain to you the available voluntary disclosure options. After you choose the voluntary disclosure option, our firm can prepare all legal documents and tax forms required for your voluntary disclosure, fully implement the ethically available strategies and rigorously defend your position against the IRS.

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